The old adage about building a retail business was that the three most important considerations were “location, location and location”. This made sense – while offline businesses like restaurants or retail stores rarely thought about “customer acquisition” in the same way that online businesses do today, the dynamics are analogous – you needed to build your operation in a way that enabled you to acquire customers profitably. Put another way, you needed to be able to attract customers without spending too much money and you needed to be able to charge them enough that they were worth that cost. Having a good location was demonstrably critical – you had to be where people either already were in large numbers, be somewhere that was already a destination for the right segment of people to whom your business appealed, or be convenient to complementary businesses for your target demographic. Thus, location location location.
Online businesses don’t have to worry about location (I’m going to sidestep the analogy between location and domain names, not because it’s illegitimate, but because it’s a separate point). Online businesses live on the web, where location is dimensionally irrelevant. So the question becomes, if offline businesses distinguish themselves fundamentally by location, how do online businesses accomplish the same distinctiveness?
Several of my friends have blogged on the topic of customer service over the past few weeks (see Josh Kopelman’s two posts on the subject, as well as Sarah Tavel and Eric Friedman’s related posts on ecommerce and customer service excellence). As I’ve observed my own use patterns over the past few years as a consumer, I’ve concluded that truly amazing customer service has replaced location as the single point of greatest leverage for online commerce (side question – can we retire the term “ecommerce” please?)
Zappos is a great example, and is always everyone’s first comment on this topic because they have done a superb job not only of creating a great customer service culture, but of promoting how superb their customer service culture is. I think the dynamic goes well beyond Zappos. In fact, while enumerating some of the early best practices that have come out of some of the pioneers in next-generation customer service is interesting and illustrative, for my money thinking about the underlying competitive dynamics is more interesting and ultimately more powerful in the long term.
As with most questions of business strategy, this analysis will ultimately hinge on competitive advantage (or lack thereof) amongst competitors within a segment. As always on this topic I refer back to Bruce Greenwald, from whom I learned most of my fundamental understanding of the sources of competitive advantage and the best ways to maintain and expand those. Location location location goes beyond the accurate but ultimately superficial explanations I gave in the first paragraph. Brick and mortar businesses that got location right built competitive advantage in their industries, particularly the larger, multi-location brands that at a core level became as much about having the right real estate as having the right product.
Consider the book business – prior to the internet, you’d talk about Barnes & Noble, WaldenBooks, Borders or B. Dalton. What were the distinguishing characteristics of these companies? You could cite little difference other than the footprint they held – who held the prime spots in the right malls? Alternately, who was building superstores elsewhere that upended the mall model? Either way, you were talking about strategies built on location, distribution and ultimately supply chains to feed the beast. Consider the book business now. Amazon owns it. And why wouldn’t they? They have every title at all times, give free shipping to just about every purchase, take things back easily and have good prices. Some of these elements are more obviously customer service than others, but I’d put all the non-price benefits under the same basic umbrella (particularly free shipping and easy returns).
Now consider Amazon as a builder of competitive advantage. Location is irrelevant, so the hundreds of millions or billions of dollars spent on retail distribution infrastructure and storefronts is sunk. Without location, how does a seller of a true commodity create competitive advantage? I believe the only answer is consumer habit, and the only real generator of that habit is superior customer service. That means considering the sources of habit and stickiness as core drivers. So what do you do if you’re Amazon? This is the genius of Amazon Prime. People love free shipping, so you get them to pay up front for free expedited shipping on everything they buy. Once you’ve spent the $79 on Amazon Prime, that free shipping benefit will draw you to Amazon whenever possible. It’s sort of the commerce equivalent of frequent flyer miles. I’d argue that this analogs of this dynamic can be found across all areas of online commerce where new entrants are using new sources of consumer retention to build lasting relationships with those consumers.
Ultimately, the demise of location as a differentiator amongst businesses seeking to sell to consumers destroys much of the competitive advantage present in these markets. I posit that in this newly-level playing field, customer loyalty can be obtained only by superior customer service. We’re going to see this thesis play out over the next few years, particularly as next-generation approaches to online commerce continue to gain scale (e.g. private flash sales, group buying platforms, subscription commerce, etc…). One possibility that I will allow for, both as an investor and as a consumer, is that the web actually is a true leveler – that there are no real sources of competitive advantage in commerce and that this will be a margin-destroying scrum that will lead to only the leanest of businesses surviving. If this is the case, operational excellence will become the determinant of winners and losers.
My thesis today, however, is that there is an opportunity for online merchants to build a sort of brand relationship with consumers, and that this opportunity hinges on stellar customer service. Those online stores and retailers who engender the trust of consumers should, under this thesis, obtain a measure of loyalty from those consumers. This thesis will be easy to test – if it’s true, the merchants who succeed will be able to charge higher prices than those who fail. If, on the other hand, Zappos and those like them, are exactly price-competitive with the field, then the correct conclusion will be that great customer service is actually a red herring. As a consumer, I certainly hope this isn’t true, and as an investor I hope the same thing, since I continue to look for online commerce businesses that have an opportunity to build something truly defensible over time.